What are Futures Contracts? With Examples

Introduction

The financial markets are full of instruments that allow investors and traders to manage risk, speculate on price movements, and diversify portfolios. Among these, Futures Contracts are one of the most popular derivatives. Futures are widely traded across commodities, currencies, equities, and indices.

If you have ever wondered what futures are, how they work, and why traders use them—this detailed guide will walk you through everything with examples.

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1. What is a Futures Contract?

A Futures Contract is a legally binding agreement between two parties to buy or sell an asset at a predetermined price on a specific future date.

• The buyer of the contract agrees to purchase the underlying asset at the set price.
• The seller agrees to deliver the asset at the set price.

Unlike stocks, which represent ownership, futures are simply contracts for trading the future price of an asset.

✅ Example:
Suppose crude oil is trading at ₹6,000 per barrel. A trader expects the price to rise and buys a futures contract for delivery in one month at the same price. If crude oil rises to ₹6,500 per barrel, the trader gains ₹500 per barrel.

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2. Key Features of Futures Contracts

1. Standardization – Contracts are standardized in terms of quantity, quality, and expiry date.
2. Leverage – Futures require only a margin deposit (not full value), so traders control large positions with less capital.
3. Mark-to-Market – Daily settlement of profit and loss.
4. Expiry Date – Futures have a set validity, usually the last Thursday of every month in India.
5. Underlying Asset – Can be commodities, currencies, equity shares, or indices.

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3. How Futures Work in Stock Market

Let’s take the example of Nifty Futures.

• Nifty spot is at 24,000.
• A trader buys Nifty Futures at 24,100 for August expiry.
• If Nifty rises to 24,500 before expiry, profit = (24,500 – 24,100) × lot size (say 50) = ₹20,000.
• If Nifty falls, losses occur in the same way.

Thus, futures amplify both profits and risks.

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4. Types of Futures Contracts

1. Stock Futures – Contracts based on individual company shares (e.g., Reliance, TCS).
2. Index Futures – Based on market indices like Nifty or Sensex.
3. Currency Futures – Based on currency pairs (e.g., USD/INR).
4. Commodity Futures – Based on physical commodities like gold, crude oil, wheat.
5. Interest Rate Futures – Based on debt instruments like government bonds.

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5. Example of Futures in Commodities

A wheat farmer wants to protect himself from price fluctuations:

• Wheat price today: ₹2,000 per quintal.
• Farmer fears prices may fall during harvest.
• He sells a futures contract at ₹2,000 for delivery in 3 months.
• Even if wheat falls to ₹1,800 later, he will still receive ₹2,000 (as per contract).

This is called hedging.

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6. Why Trade Futures?

a) Hedging

Businesses and investors use futures to protect themselves against price volatility.

b) Speculation

Traders buy or sell futures to profit from expected price movements.

c) Arbitrage

Taking advantage of price differences between spot and futures markets.

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7. Margins in Futures

To trade futures, traders do not pay the full contract value. Instead, they deposit a margin (5–15% of contract value).

✅ Example:
If Reliance Futures contract value is ₹25,00,000 and margin is 10%, you only need ₹2,50,000 to trade it.

This leverage magnifies gains but also increases risk.

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8. Risks in Futures Trading

1. High Leverage Risk – Small price changes can cause big losses.
2. Time Decay – Futures lose value as expiry approaches if the market does not move in your favor.
3. Market Volatility – Sudden changes can trigger margin calls.
4. Liquidity Risk – Some contracts may not have enough buyers/sellers.

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9. Practical Example of Futures Trading in Indian Market

Let’s say you expect Infosys stock (currently ₹1,500) to rise.

• You buy 1 Infosys futures lot (lot size = 300 shares) at ₹1,510.
• Contract value = ₹1,510 × 300 = ₹4,53,000.
• Margin required (10%) = ₹45,300.

If Infosys rises to ₹1,600:
Profit = (₹1,600 – ₹1,510) × 300 = ₹27,000.

If Infosys falls to ₹1,450:
Loss = (₹1,510 – ₹1,450) × 300 = ₹18,000.

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10. Difference Between Futures and Options

Feature	Futures	Options
Obligation	Buyer & Seller both obligated	Buyer has right, seller has obligation
Risk	Unlimited	Limited (for buyer)
Premium Payment	No premium, margin required	Buyer pays premium
Usage	Hedging, speculation	Hedging, speculation, income strategies

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11. Advantages of Futures

• Highly liquid and standardized
• Provide leverage
• Useful for hedging
• Can trade a wide range of assets

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12. Limitations of Futures

• High risk due to leverage
• Limited timeframe (expiry dates)
• Requires constant monitoring
• Not suitable for beginners without knowledge

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13. Futures Market in India

In India, futures are traded on exchanges like:

• NSE (National Stock Exchange) – Equity & Index futures
• MCX (Multi Commodity Exchange) – Commodities futures
• BSE (Bombay Stock Exchange) – Equity futures
• NCDX – Agricultural commodities

Futures are regulated by SEBI (Securities and Exchange Board of India).

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14. Futures Contract Lifecycle

1. Initiation – Contract is created and traded.
2. Trading – Traders buy and sell in futures market.
3. Mark-to-Market – Daily settlement of gains/losses.
4. Expiry – Contract is settled either in cash or delivery.

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15. Conclusion

Futures contracts are powerful tools that allow traders and businesses to speculate, hedge, and manage risk. While they offer leverage and opportunities, they also carry high risks.

For beginners, it is important to first understand the basics, practice in simulations or small lots, and only then step into futures trading.

Futures are like a double-edged sword: they can help you multiply wealth, but if not used carefully, they can also lead to big losses.

📌Disclaimer – At BullBearFin, we don’t provide trading tips but focus on helping you understand financial markets better so you can make informed decisions.

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